The challenge of populism

May 2019

By calling into question the two pillars of capitalism, free trade and free markets, the populist wave sweeping through the world is increasing political volatility and could contribute to higher inflation and lower growth.

While our central scenario is that innovation will be a more important factor in expected returns in the coming 10 years, the heterogeneous mix of populist movements that have emerged in recent years could threaten global economic growth, and therefore asset returns, in the long term. As mainstream parties are finding it hard to deal with this disruption, the outcome of elections in Western democracies is becoming increasingly difficult to predict, elevating political stress. Populism could spill over into geopolitics: the rise in nationalism, in particular of American isolationism, could threaten the global world order, increase global tensions and ultimately warrant higher risk premia for financial assets.

Populism has been fed lingering resentment since the global financial crisis in 2008, which struck developed economies particularly hard. The crisis forced governments to rescue big banks, creating the impression that they are more on the side of big business than of the man in the street. Popular resentment has been compounded by the strict austerity policies to contain the rise in budget deficits introduced in many countries (with mixed success in most cases). Further adding to the impression that ordinary people have been losing out has been an increase in corporations’ profit margins as a share of GDP to well above the average since the 1970s (see chart). High and rising corporate power, combined with the rise of alternative work arrangements (the so-called ‘gig economy’), has added to deflationist pressure on wages. The disconnect between financial market returns and wages in recent years has added further to people’s anger.

It would be easy to think that populism will ebb as the reality of power or economic difficulties saps support. But the endemic economic and social disruption produced by globalisation and innovation could ensure that populists continue to have an audience for years to come.

Measuring just how far long-run growth potential is damaged when populists’ efforts to stimulate demand boost headline growth in the short term is challenging. But once demand stimulus runs out of steam and attention turns to longer-run issues, the success of populists’ economic policies tend to come to an abrupt end.

Since the economic and social forces that have fed the rise in populism over the past 10 years may continue to shape the coming 10 years as well, Western democracies will probably continue to face more unpredictable electoral contests. The experience of 2017 and 2018, with markets nervously anticipating successive elections in different European countries for possible populist breakthroughs, could become the norm. The Italian general elections of 2018, which brought a populist alliance to power, could be a taste of things to come, with the cohesion of the euro area again being called into question at one stage. Moreover, populist parties do not necessarily have to enter government to exert substantial influence on the policy agenda (witness the impact that the UK Independence Party has had on British parties in recent years, in spite of only ever holding one parliamentary seat before it imploded).

We also recognise that technological evolution and sudden regime shifts can also nurture populist forces. We know as well that populism and populist agendas can take time to unfurl. Bottom line: while not our central scenario, we may have to live with the populist threat for years to come. In terms of the macroeconomy, a greater role for populists in politics, either within governments or as a major influence on policy, would probably imply weaker real economic growth and higher inflation over time, in part as a result of increased protectionism and also because of less optimal economic policymaking in general.

For investors, the implications of the rise in populism include increased volatility around the political cycle, and spikes in volatility if populists achieve or look set to achieve breakthroughs. These periods will be marked by decorrelation between bonds and equities, with prices falling for equities and rising for bonds.

More broadly, political uncertainty is likely to add to the attraction of high-quality and defensive equities, and safe-haven government bonds. Gold’s appeal would also probably be boosted by a widespread populist surge. Since, unlike currencies and bonds, it is not tied to the political fortunes of any particular country, it is the purest safe-haven asset for political protection.

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